The state of the economy when oil prices slump to US$45 per barrel

Malaysia is one of the few East Asia countries that is a net exporter of petroleum and natural gas. The government derives a significant portion of revenues from oil royalties and taxes mainly contributed by national oil corporation Petroliam Nasional Bhd (Petronas).

Global crude oil prices have dropped to almost 6-year low on concerns of a global supply glut. Oil has slumped over 50% in the last 12 months, the biggest free-fall since the 2008 global financial crisis, as the US expand its output at the fastest rate in more than three decades and the Organization of Petroleum Exporting Countries (OPEC) resisted calls to cut production.

In Asia, the plunge in crude oil and commodity prices were generally seen as beneficial, especially to major oil-importing economies. Lower oil prices would ease inflationary pressures throughout much of Asia.

Helped by lower oil prices, countries like Indonesia and Malaysia have removed fuel subsidies. Some economists mentioned this was a good opportunity for these governments to unshackle their fiscal position from the subsidy scourge once and for all. Removal of fuel subsidies were better received this time compared to the occasional occurrence of rallies and protests whenever fuel subsidies were cut in the past. Latest data has shown that real inflation has slowed in both countries.

However, low energy prices are not entirely beneficial to the region. Malaysia, for instance, derived approximately 30% of its national income from oil revenues – being a net oil exporter. Malaysia’s large infrastructure programs are expected to be financed with oil revenues, with additional pain likely to come from falling prices of other key commodity exports such as palm oil and rubber.

Drop in oil prices will renew pressure on the Malaysian currency. The ringgit fell to a 5-1/2 year low versus the greenback, continuing its underperformance amongst major Asian currencies. The cost of insuring Malaysian sovereign debt has risen the most this year compared with that of its Southeast Asian peers as state investor 1Malaysia Development Bhd’s (1MDB) financing woes grew besides the deepening concerns about the country’s account balance.

Fitch Ratings have put Malaysia on a “negative” outlook to reflect the erosion of the current account surplus amid large public sector deficits. Fiscal policy becomes more challenging as oil prices fall. Already a planned mega merger of banks was called off citing the change of economic climate that is becoming tougher due to deteriorating loan growth and worsening margins across the industry. Lower corporate earnings were signs of a slowing, moderating economy.

Malaysia is also expected to implement a Goods and Services Tax regime come April this year. The measure was announced before the slide in energy prices. Economists are pointing to a slower private consumption based on past experiences derived from tax regime changes in other countries. The GST implementation is expected to induce a slight inflation that will offset the benefits of low fuel prices.

Despite the choppy short-term outlook, Malaysia is expected to achieve a commendable, but lower GDP growth of 4.5% to 5.0% this year due to slightly better performing manufacturing exports, continued construction sector-driven growth and stabilisation of the economy towards the end of the year.